Guru Strategy: Stocks don't reflect the economy's danger signs, so beware

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The stock market's fall last week was not dramatic enough to alarm investors. But there are signs that things could be getting worse. Jack Adamo, editor of the newsletter Insiders Plus, warns that danger lurks if individual investors remain complacent while bigger players quietly sell their investments and "slip out the back door."

It's worth listening to Adamo. Adamo focuses on insider transactions, which often can tip off investors as to where stock prices are headed. He also analyzes smart money plays by wealthy investors such as Warren Buffett and Sam Zell. What's more, he uncovers stocks that are undervalued as a result of special situations. The result of all this handiwork has been market-beating returns. Over the past five years, Insiders Plushas delivered an 8.7 percent annualized return, versus a loss for all the major averages, according to Hulbert Financial Digest.

DailyFinance interviewed Jack Adamo about the economy's danger signs.

DailyFinance: In a recent issue of your newsletter, you pointed out that mutual fund inflows into equities continue to slide. Is this something to be worried about?
Adamo:
Equity funds had net outflows of 1.7 billion reported last week, compared to outflows of 1.3 billion the week before. That's four weeks in a row of outflows. But that may be more of a sentiment indicator than anything else at this point.

Why is that?
If you factor money flows into hybrid funds -- which are typically allocated 60 percent to stocks and 40 percent to bonds -- the net inflows into stocks are still positive. That number was about a billion last week, but has been volatile. Over the past four weeks, net withdrawals have been about $2 billion total. From a market perspective, the bottom line is that neither technical signals, nor money flow are critical yet, but the latter could become an issue soon.

What about on the economic front?
There, the story is different. We are continuing to get just enough data that is actually positive, or at least it can be spun to look that way. But the weight of evidence is still far from rosy.

For example?
The headline the bulls touted was that the S&P/Case-Shiller composite index of house prices in 20 metropolitan areas rose 1.6 percent in July from June, more than triple the 0.5 percent rise expected. But that was about it on the plus side of the ledger, except for a few small things nobody mentioned in the transportation figures. The American Trucking Associations' advance seasonally adjusted For-Hire Truck Tonnage Index increased 2.1 percent in August, matching July's increase. It was still down 7.5 percent year-over-year, but that was the smallest drop since November. We can be grateful for small favors.

What else worries you?
The rail reports. U.S. and Canadian car loadings and intermodal traffic were down mid- to high-teens percentages from last year, showing no discernible improvement over the last several months. Mexican car loadings improved dramatically over last week, down "only" 8.9 percent year-over-year. However, we had one of those blips about a month ago, only to go back down the next week. Intermodal traffic was down 13.9 percent; so, no great shakes there either.

Were the declines in rail traffic indicative of declines in other transportation sectors?
In air traffic, passenger demand was down 1.1 percent year-over-year compared to a 2.9 percent decline in July, and freight demand fell by 9.6 percent, also an improvement compared to the 11.3 percent drop in July. But despite these month-over-month improvements and tighter supply, average fares continue to be depressed. Premium seat fares are down 22 percent year-over-year and economy fares are down 18 percent.

Are there any indicators that things are looking better?
One place we could look for a glimmer of hope, albeit a small one, is from the American Institute of Architects. Its billings index for August stood at 41.7, down from 43.1 in July and 46.5 in August 2008; so that is bad and getting worse. A number higher than 50 indicates an increase in contracted work. But inquiries rose into plus territory, pointing to a possible rise in work in the future, although the institute's chief economist said builders are still having great difficulty financing projects.

Based on these indicators, it seems investors should still expect tough times ahead.
Unfortunately, there are no green shoots or glimmers of hope to be found among the very important employment statistics. New claims rose an unexpectedly large 17,000 to 551,000, while nonfarm payrolls showed a monthly drop of 263,000, again, much, much worse than the 175,000 lost jobs anticipated. We can look for some hope in the fact that the privately calculated ADP report showed a somewhat less drastic loss of 254,000 jobs -- still not a delight to hear.

The government's numbers get worse, the deeper you look into them. They just published the revisions to the March nonfarm payrolls. Due to the inaccurate estimates in the birth/death rate of businesses, the March numbers understated the decrease in March payrolls by a staggering 824,000 jobs. That's on top of the 2.1 million they previously reported. This does not give one great faith in the accuracy of these preliminary data releases, nor the green shoots we've been led to expect.

A drop in unemployment would be a true sign that things are getting better.
John Mauldin this week quoted some calculations from David Rosenberg, the very bright ex- Merrill Lynch economist who struck out on his own, presumably to make an honest living. If we stopped losing jobs today, which we won't, just to get back to five percent unemployment within five years we would need to create 250,000 jobs per month. In the best 10-year period he could find (1991-2000), the average number of new jobs created per month was only 150,000. We have a long way to go.

Jack Adamo is the Editor of Insiders Plus.

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